In a Swirling Storm, the Fed Governors Stay Calm

By RICHARD W. STEVENSON

Published: June 8, 1996

WASHINGTON, June 7—
By 9:15 this morning, when the Federal Reserve Governor Lawrence B. Lindsey arrived at his office, the bond market had already rendered its judgment on the news, released 45 minutes earlier, that employment growth in May was stronger than expected: It sent long-term interest rates sharply higher in the expectation that the Fed would soon tighten monetary policy to cool down an economy at risk of overheating.

By the end of the day, the price of the 30-year Treasury bond was down 112/32 , its biggest decline in two months, driving the yield up to 7.02 percent from 6.89 percent on Thursday. The stock market initially plunged, falling nearly 87 points, then recovered, with the Dow Jones industrial average finishing at 5697.11, up 29.92.

But if the financial markets were in a tizzy, Mr. Lindsey, as one of those who will actually set policy when the Fed next meets to consider raising interest rates on July 2 and 3, could afford to be more measured and upbeat in his assessment of the same numbers.

Walking back into his office this morning after returning from a one-day trip to Salt Lake City, he looked at the employment numbers and the market reaction on his computer screen, then scanned the news release from the Labor Department for some of the details. Although the number of jobs created in May was higher than most economists expected, the index of hours worked remained slightly below where it had been in February and March, he noted.

"Not shocking," Mr. Lindsey said. And while he said he would not study the employment report in depth until Monday, he went on to deliver a sanguine analysis of the economy, similar to those of other Fed officials in recent weeks, concluding that the most likely outlook was for a continuation of "sustained moderate growth."

Whether the Fed will raise rates next month remains an open question, and it is unclear whether Mr. Lindsey's assessment means that he would not support a tightening. But a visit with Mr. Lindsey today made clear that if nothing else, there is a big gulf between the way financial markets respond to economic statistics and the way the Fed digests them.

In the markets, the monthly employment report has become the single most important indicator of economic strength, potential inflation and Fed strategy. Over the last few months in particular, traders have been almost fixated on the reports as they seek to discern the inflation outlook and the Fed's policy intentions.

Today's report, showing that the economy created 348,000 payroll jobs in May, prompted an emphatic and nearly instantaneous response in the bond market. News wires and television screens were filled with economists opining that the Fed would almost certainly have to respond, either in July or August, with at least a quarter-point increase in the Federal funds target rate to keep inflationary pressures from taking root.

But for Mr. Lindsey, the employment report was just "one piece of a puzzle," as he put it, and not one that by itself should be the basis for a policy decision.

"To believe that anyone here is going to stand up and say, 'The May employment was such and such, so we're going to have to raise rates,' that's just preposterous," Mr. Lindsey said.

Mr. Lindsey ticked off a series of reasons to be optimistic that the economy would neither overheat nor lapse into recession. The banking system is healthy. While labor markets are tightening somewhat, they don't yet signal any significant inflationary pressures.

Consumer spending, while remaining relatively robust, is unlikely to grow at a strong rate because of high consumer debt levels. Investment by business, which has been running at double-digit rates in recent years, seems unlikely to grow at a faster pace this year and probably will grow considerably more slowly. Government outlays are roughly flat, and net exports seem to be inching down.

"The pieces of the puzzle fall in place best for sustained moderate growth," Mr. Lindsey said.

Trying to divine the Fed's intentions is an industry unto itself, but not a very scientific one. Last week the bond markets tumbled after reading comments by J. Alfred Broaddus Jr., the president of the Federal Reserve Bank of Richmond, as a signal that the Fed would raise rates. Mr. Broaddus had said the Fed needed to be especially vigilant about inflation with the economy operating near its capacity.

This week, Mr. Broaddus made a series of statements that the markets interpreted more positively. In one, he said that while the risks of the economy overheating had become "more pronounced," there was a roughly equal risk of the economy softening later in the year.

Despite some suspicion in the markets that Fed officials coordinate their public statements to influence the markets deliberately, thereby moving long-term interest rates up and down without making any formal policy decisions, Mr. Lindsey said Fed governors almost never talk to each other about policy between meetings.

"This is the most independent-minded group of curmudgeons assembled in any given place," Mr. Lindsey said. "Curmudgeons don't conspire."

Mr. Lindsey said that it is to be expected that the markets and the Fed would respond differently to economic statistics.

"As an economist I believe that people follow the incentives provided to them, and the incentive provided to traders, who in the short run move the markets, is a trade," Mr. Lindsey said.

"That means exaggerating the importance of any given number. Our incentives here are different."